Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus ex Machina?

Loriana Pelizzon, Marti G. Subrahmanyam, Davide Tomio, Jun Uno

Research output: Contribution to conferencePaperResearchpeer-review


This paper examines the dynamic relationship between credit risk and liquidity in the sovereign bond market in the context of the European Central Bank (ECB) interventions. Using comprehensive set of liquidity measures obtained from a detailed, quote-level dataset for the largest interdealer market for Italian government bonds, we show that changes in credit risk, as measured by the credit default swap (CDS) spread, generally drive the liquidity of the market. The relationship is stronger and tighter when the CDS spread is above 500 basis points. This threshold was estimated endogenously and can be ascribed mainly to changes in margins and collateral. Moreover, we show that the long-term refinancing operations (LTRO) intervention by the ECB weakened the sensitivity of the liquidity provision by the market makers to changes in the Italian government's credit risk, by providing them with vastly expanded funding liquidity. Finally, we document the importance of market-wide and dealer-specific funding liquidity measures in determining the market liquidity for Italian government bonds.
Original languageEnglish
Publication dateJul 2014
Number of pages73
Publication statusPublished - Jul 2014
EventThe 8th Annual Risk Management Conference 2014: Risk Management Amidst Global Rebalancing - National University of Singapore, Singapore
Duration: 10 Jul 201411 Jul 2014
Conference number: 8


ConferenceThe 8th Annual Risk Management Conference 2014
LocationNational University of Singapore
Internet address

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